GSE Portfolios: ‘Legacy Of The Decade Of Abuse’
An account of the ‘internal’ investigation of Fannie Mae showed up in the Australian press. ” The $US11 billion accounting fraud at Fannie Mae stemmed from an ‘earnings at any cost culture’ and the US mortgage giant still posed a systemic threat to financial markets, Randy Quarles, undersecretary for domestic finance at the US Treasury, said.”
“A 17-month internal investigation into Fannie Mae’s accounting practices, released on Thursday, exposed no new irregularities and did not implicate any of the government-sponsored enterprise’s current management.”
“Mr Quarles renewed criticisms that Fannie’s $US1.4 trillion portfolio was not justified by its government mandate of promoting the spread of home ownership, and said any reduction in the portfolio could be staggered over time and need not disrupt financial markets. ‘The large portfolio is the legacy of the decade of abuse,’ Mr Quarles said. ‘We might have a better controlled and accounted-for systemic risk now, but it is still a systemic risk.’”
“He acknowledged that the report had found that the accounting violations and corporate governance deficiencies were being repaired, but insisted: ‘The broad systemic risks inherent in the retained portfolio that was at the heart of the process remain unchanged.’”
“Concerns about the errors at Fannie and at Freddie Mac, its smaller rival, have led to congressional attempts to toughen the monitoring of the two, which are the biggest bond market borrowers in the US after the federal government.”
“The 2652-page report did not find evidence that the accounting irregularities were associated with a desire to maximise executive bonuses, except in one instance, but were instead ‘motivated by a desire to show stable earnings growth, achieve forecast earnings and avoid income statement volatility.’”
“Employees in crucial accounting positions ‘were either unqualified for their positions, did not understand their roles or failed to carry out their roles properly,’ it said. Accounting systems were also ‘grossly inadequate.’”
“The report found Fannie’s former chief financial officer Timothy Howard and former controller Leanne Spencer to be ‘primarily responsible’ for the poor accounting. However, it cleared Franklin Raines, who was forced to resign as chief executive when the problems came to light, saying he did not know about the irregularities, although he had contributed to a culture that improperly stressed stable earnings and steady growth.”
‘the biggest bond market borrowers in the US after the federal government’
And the taxpayer is expected to back this mess up? Where is the result of the Justice Dept. investigation?
Freddie and Fannie are specifically and by law in bold letters NOT in any way backed by the government.
I know that and you know that, but then why do Moodys, Fitch and S&P tell the mortgage market different? Check out my posts on that subject last spring, on the original HB blog.
Sorry to sound stupid. What exactly does this mean for the market? Obviously, they have a risky porfolio due to all of the creative financing. Will the accounting fraud cause lending restrictions to tighten? Will it create less demand for mortage backed securities?
IMHO as the housing bubble bursts the mortgages backed by Fannie Mae and Freddie Mac may go into significant default. If this happens to a greater degree than reserves held by Fannie and Freddie (the companies have not presented acceptable reports for 17 months) then the tax payers are liable. Whoopdeedoo! To mitigate damages the banks will be forced to liquidate further limiting the buying pool and accelerating the collapse.
I thought that Fannie Mae and Freddie MAC loans being guaranteed by the government (i.e. taxpayers) is a fallacy. That any govt guarantee was gone once the govt shed them (Fannie and Freddie) and they became corporations. Won’t the people who eat it be the investors who bought the Fannie and Freddie packaged mortgage backed securities?
Rembember the $200b promised in Katrina aid on the morning after the disaster last fall? When the Fannie collapse takes place, expect a similar emergency measure to throw taxpayer $$$ into a bailout package.
Yes, but dont expect the money to arrive. New York City is still waiting for 9/11 money.
And New York City still has a big hole in the ground with no plans in place!!
Promises, promises
I’m all through with promises, promises now
I don’t know how I got the nerve to walk out
If I shout, remember I feel free
Now I can look at myself and be proud
I’m laughing out loud
I think both sides are right, Fannie and Freddie do have government backing, but I think the amount is less than 1% of the total of the mortgages they back, and so is not very significant unless the government tries a bailout, which would be a total disaster. They were originally government agencies, but now are private.
Delinquencies are already trending up in both FRE’s and FNM’s portfolio. In fact, FNM’s December portfolio delinquency rate of 0.77% is the highest going back many, many years.
http://www.fanniemae.com/ir/pdf/monthly/2005/123105.pdf
FRE just reported a 0.69% delinquency rate, the highest since last February:
http://www.freddiemac.com/investors/volsum/pdf/0106mvs.pdf
These numbers are coming off very low levels … and investors are buying the whole “the hurricanes ate my borrowers” excuse as the reason for the rise in late payments. But as we put more distance between us and Katrina — and the delinquencies continue rising anyway — you’ll see people start to wise up. Or that’s what I think, for what it’s worth.
‘We might have a better controlled and accounted-for systemic risk now, but it is still a systemic risk.’
I think he should withhold judgment at least until the missing financials are produced.
“However, it cleared Franklin Raines, who was forced to resign as chief executive when the problems came to light, saying he did not know about the irregularities, although he had contributed to a culture that improperly stressed stable earnings and steady growth.”
Wow — the Ebbers defence resurfaces:
http://money.cnn.com/2005/03/15/news/newsmakers/ebbers/?cnn=yes
Their books are about as cooked as you can get. Maybe they need to get some help from h & r block? Seems they can’t even get their books straight these days. I hope they throw the crooks in in jail and let them rot.
It matters to the bond markets because fannie and freddie debt (agency debentures) are very popular with banks, insurance companies, foriegn central banks, etc, because they offer a bit of yield pickup over US government bonds but have an implied AAA rating.
As we have seen with the troubles of many mortgage reits, managing a portfolio of MBS is tough, especially in an flat yield curve environment. Even if they aren’t taking credit risk due the relatively strict lending guidlines for GSE backed MBS, they still have lots of interest rate risk. And if they starting dumping thier MBS portfolios on the market it would remove a big bid from mortgage land and cause the value of MBS to fall further, which would lead to further asset impairment writedowns at the mortgage reit.
My personal opinion would be to let Fannie and Freddie do what they are good at, packing mortgages into MBS, and prohibit them from taking advantage of an implied goverment subsidy (cheaper funding costs) to hold MBS on thier own balance sheet.
1) Good thing that Fannie also operates a hedge fund which doubtless allows them to insure this risk.
2) You omitted pension funds from your list of interested parties; the risk of a housing collapse to pensioners seems rather frightening. Fiduciaries can use the “everyone else did it” defence to protect themselves against charges that they were breaching their duty by loading up on MBS (much as they did in the wake of the .com/telecom bust a few years back!).
I worked at a pension fund and aside from not growing as quickly for a couple of years (and an ill timed pension benefit increase that our legislature gave the teachers), the .com bubble really didn’t cost us too much. We got stung by Enron and Worldcom, but they were pretty modest losses (I think we might have made money on Enron equity). We more than made up for those losses with cheap Q debt. I don’t know of any DB pension funds that had the bank broken due to the .com bust.
The real issues in pension funds are that corporations got used to not making contributions through the 90s because their investments were going up, funding not only the contributions, but also the ability to increase pension benefits without any seeming cost to the company. When that stopped, companies had to start making regular contributions again (and in some cases making contributions to cover the lack of contributions for that they had not been making for the prior 3 years or so).
Not so for the SD city govt pension plan, which figured out how to increase benefits and waive funding requirements in the wake of the .com collapse.
It wasn’t the lack of returns, it was the lack of contributions from SD which had gotten quite used to promising beneifits that it didn’t think it would have to actually fund. Their investments earned 7% in the years 1999-2004 (2000-2003 were flat but no losses).
It wasn’t poor investments that drove them to the current position. The city of San Diego (like many pension funds) raised benefits in the 1990s and or cut contributions at the same time (thanks to 15%+ annual asset returns) and liabilities that were only gowing at 6-8% most likely. When the 15% returns are great, but you shouldn’t budget like they will continue through retirement.
Some folks (names omitted) suspect defined benefit schemes are designed for the purpose of taking the money and running. Procyclical funding through loading the pension fund with equities reduces funding requirements during the good times and sinks the fund during the bad times, which is coincidently one of the best times for a company to declare bankruptcy (after the big boys have already floated to earth with their golden parachutes!).
This works best for private corporations, as cities have a much harder time shuddering their operations than corporations do.
LET THEM EAT CAKE!
Oops, I meant “shuttering” (my Freudian slip is showing).
This all makes me angry. People involved in this should go to jail, but they probably will not…Kind of like Enron, the mismanaged funds in Hurrican Katrina, and the billions of Iraqui dollars held in trust by U.S. Government still not accounted for.
O.k. I am sure it doesn’t end here. Someone want to help me out here? Well, maybe we should just not get too worked up. I still love my country.
I am angry also. I am a Republican, but Bush and these other “neo-cons” are destroying this country. He has outspent any other supposed “Spend-o-crat” in history. He has started new beuracracies (homeland “security”). And finally, maybe its just the speed of the internet but, any facade of elected officials representing their constituents best interests is gone now. The casual connections between Bush, Cheney, Enron, Iraq, Saudi Arabia, etc are just too great. One hand washing the other. The amount of money these special interest groups have made off of this administration is staggering.
As you stand in line at airport “security” and see old women and wheelchair bound children getting patted down and searched by $12 an hour workers, think about how our government has given preferential treatment to the “real” terrorists. Bin Laden families, Saudi Royalty, all flying home during the shutdown of our air traffic system. Sad.
And don’t get me started on the “Patriot” act. Our founding fathers are rolling over in their graves. It’s anything but Patriotic. Very “1984″ Orwellian to name it that.
Well said, Mr./Ms. Barnum!
test
Ben:
Just saw this out on CNNMoney.com
Cancelled home orders: Latest bubble prick?
Experts say jump in cancelled orders for new homes is latest sign of how investors inflated the real estate market recently, and how the market is due for a downturn.
http://money.cnn.com/2006/02/24/real_estate/home_cancellations/index.htm
Raines will never do time
federally protected AA
Fannie Mae $11 Billion. To think, it was only a $1Billion that caused Enron to implode. And it was one time, the 7th largest company in value in the country, worth many billions. What will this say about Fannie and that the $11Billion is most likely very understated. A lot of crooks need to tossed in a gladiator ring (along with Ebbers and Lay). Screw up all’.
Ciao
Excessive focus upon these giants misses the (much) larger picture. The way the enormous expansion of credit and mortgage lending has occurred is through the packaging of obscene numbers of Mortgage Backed Securities. These are devices which allow the lender to resell the mortgages as part of a bulk parcel on a secondary market, thereby recapitalizing so they can … make more loans. Every time they made a loan they made money. Every time they packaged loans into another MBS, and sold it, they made more money. They have been, in effect, shoveling out loans for the last half-decade, with no regard whatsoever for how, when or who will collect them when they go into default. They know only that it will not be them on the hook if there is a problem, it will be the investors in the MBS. This has contributed to an industry-wide lack of regard for lending proprieties such as wage and income verification, downpayments, owner occupancy, etc. The market is supposed to be self-regulating; that is, sloppy loans should not be able to be sold. Nobody wants “B” paper. At least, never before. Unfortunately, with the way this bubble has developed, nobody cared whether the loans were sloppy, properly documented or anything as long as they had another loan to package and sell. Investors, glassy-eyed with greed, have been buying MBSs like there is no tomorrow with absolutely no regard for the long-term return or collectibility of the secured debt.
When people stop buying the MBSs, the lenders will need to a) keep their own loans and live with the consequences of default, which will b) sharply increase underwriting and diligence regarding loan apps, and c) decrease the capital the lenders can shovel out. This will effectively raise interest rates on loans, which will place a further pinch on credit. This is, of course, a best-case scenario…
Nicely struck!